Home loan interest rates on their way down

The high interest rate regime lasted a couple of years. The interest rates started peaking around the middle of last year. Finally, they started softening from October 2008 when the Reserve Bank of India (RBI) announced sharp cuts in the repo rate and cash reserve ratio (CRR). The cut in the repo rate meant banks would have funds available at a lower cost. On the other hand, the cut in the CRR meant banks would have to keep less money with the RBI, and hence had more money to lend.

Prime lending rates cut

In order to boost demand, the government put pressure on banks to cut rates. But most banks did not pass on the rate cut benefit to all customers. They did not cut their prime lending rates (PLRs) immediately. Instead, they announced reduced interest rates on new loans - up to Rs 20 lakhs. This is because banks were locked in with higher interest rate deposits. They had to wait for the initial sentiments to settle down before cutting the PLR. Slowly, with competitive pressure and settlement of higher interest rate deposits, banks passed on the benefits to all customers by cutting the PLR last month. This process took a couple of months from the time the RBI announced the rate cuts.

Stimulus package to boost consumer sentiment

The RBI and government have announced another stimulus package last week in order to boost the confidence and sentiments of domestic consumers. A more positive consumer sentiment is expected to result in higher demand and hence higher GDP growth. As part of the monetary policy measures, the RBI announced sharp cut in the CRR, repo and reverse repo rates. The key monetary policy parameters have come down sharply from their peak in September 2008, over the last three months.

The government is hopeful banks will pass on the interest rate cuts to the borrowers. However, many banks have indicated clearly that rate cuts are certain in future. Just how much the rates will drop will depend on several factors including amount of higher interest rate bearing deposits, inflation, risk profile, and loan amount. Analysts believe banks will start cutting rates over the next 6-8 weeks. There may be a 1-2 percent drop in banks' PLR by the end of March this year, provided the inflation rate drops below five percent.

Experts believe that next few months are very good for people looking at investing in a property. Property prices have corrected and home loan interest rates are heading downwards.

Floating rate better

In a soft monetary policy environment, people planning to take a loan should opt for the floating rate of interest option. In a floating interest rate account, the rate of interest is linked to the bank's PLR. The interest rate comes down if the bank reduces its PLR and vice versa. Since the interest rates are expected to come down in future, borrowers should choose the floating rate option. If the bank reduces its PLR in future, the borrower will automatically get the benefit of a lower interest rate.

It is also important to check other options offered by banks while taking a home loan. For example, the option and cost of switching from a floating to fixed interest rate scheme, conditions of foreclosure or partial prepayments etc. Borrowers can use the option of switching from a floating interest rate to a fixed interest rate in future, when the interest rates bottom out.

Expectations of further cuts

Analysts believe there may not be further cuts in the monetary policy parameters (repo rate, reverse repo rate and CRR) in the next 6-9 months. This is because the RBI has already announced rate cuts three times in the last three months. The RBI will wait and watch the effect of these cuts on the economy and domestic demand over the next few months. Experts believe it will take 6-9 months before we see the effect of these monetary policy measures on the economic data.